Let them fail

Peter J. Boettke

27 September 2008

The market economy is a profit and loss system. Imprudent decisions do require correction – if not by the individuals themselves, then by others who enter into the market in the hope of realising the profit opportunities others are mistakenly leaving on the table. This is how markets work; this is how markets self-correct.

The self-correction properties of the market economy are perhaps the most important lesson of economic science (not an issue of faith) that must be communicated to the general public. Unfortunately, this fundamental truth of economic theory is one of the first casualties of crises.

Firms enter and exit all the time in a vibrant market economy. During my days as an economist/Sovietologist one of the factoids I peppered my public talks with was the number of bankruptcies in New York City in one month in 1995 versus the number of bankruptcies in the whole of Russia from 1991 to 1995. The number in NYC swamped the number in Russia. Firms get driven from the market, executives who made poor decisions lose their jobs, and industries that no longer meet consumer demands become obsolete. Was it a crisis for water-carriers to be driven from the market by the innovation of indoor plumbing, or for the whaling industry in New England to be displaced when electric lighting became widespread?

Resources do not disappear, they get reallocated. The market process is a mechanism for the continual re-evaluation and re-shuffling of scarce resources among alternative uses. This is what is meant when we refer to the market as a dynamic process of entrepreneurial discovery and learning.

The most important “wisdom” of market process theory is to get out of the way of the process of adjustment. The poor decisions in one period must be penalised, the malinvestments made by businesses must be cleaned out and the opportunities for hitherto unrecognised profit opportunities must be allowed to be exploited. Bailouts, regulations, taxes, redistribution and inflation only hinder the ability of the market to self-correct.

Besides the economics, there are also constitutional and ethical issues that should be considered when such sweeping legislation is proposed. Consider the classic essay Not Yours to Give by Davey Crockett. There is also a consequentialist issue at stake. A free society works best when the need for the policemen (read in this case regulator) is least. Individuals must be equipped to embrace the troubles of thinking and the cares of living if they are to live freely as a self-governing citizenry.

The consequences of our current policy path are dire in terms of economics, politics and freedom.

This article reminds me of: - SHYLOCK: The pound of flesh which I demand of him Is deerely bought, ’tis mine, and I will haue it.which I take to refer to any lawful but nevertheless unreasonable recompense dates to the late 18th century. Perhaps financial rules are for the guidance of wise men and for the obedience of fools.I prefer Ecclesiastes 3 – A Time for Everything
3 ….. a time to tear down and a time to build, Sometimes a firm needs to fall, sometimes to be rescued.

Submitted by Jan Karlstrom on Thu, 09/10/2008 - 17:50.

But does this apply to the financial sector? When a non-financial company fail it seems to improve the situation for the remaining competitors, but in the financial market a bankruptcy marks the start of a domino process, making it necessary for government to step in. It seems to me that there is a weakness in the way the banks are structured, specifically in their ability to create (bank-)credit. Do we perhaps need a new ‘Peel’s Act’?

Submitted by Geoff Bantock on Sun, 28/09/2008 - 17:50.

This article reminds me of: - SHYLOCK: The pound of flesh which I demand of him Is deerely bought, ’tis mine, and I will haue it.which I take to refer to any lawful but nevertheless unreasonable recompense dates to the late 18th century. Perhaps financial rules are for the guidance of wise men and for the obedience of fools.I prefer Ecclesiastes 3 – A Time for Everything
3 ….. a time to tear down and a time to build, Sometimes a firm needs to fall, sometimes to be rescued.

Submitted by Jan Karlstrom on Thu, 09/10/2008 - 17:50.

But does this apply to the financial sector? When a non-financial company fail it seems to improve the situation for the remaining competitors, but in the financial market a bankruptcy marks the start of a domino process, making it necessary for government to step in. It seems to me that there is a weakness in the way the banks are structured, specifically in their ability to create (bank-)credit. Do we perhaps need a new ‘Peel’s Act’?

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